Shockproofing Your Nest Egg

November 11, 2004

By Ellen Hoffman A 55-year-old divorced man took an early-retirement offer from his company and then set up his own successful consulting business in the telecommunications field. Two years later, his 90-year-old mother had to move into an assisted-living complex. The son spends so much time taking care of his mother's affairs and visiting her daily that his business has faltered. He's currently living on the early-retirement buyout money.

Karen Norman, a financial planner in Dearborn, Mich., points out that this client could face another year or more with little or no income. Even if he's able to regenerate his business, he'll certainly have to change his lifestyle, she says. What's more, he may have to start collecting Social Security payments earlier than he had hoped. His original target age -- 66 -- may no longer be practical. (A recent report by the Family Caregivers Alliance, a San Francisco-based nonprofit, describes the toll that caregiving can take on the caregiver's retirement finances.)

A COPING PLAN. Retirement is probably the last thing that comes to mind if you're in the midst of a major life change, especially an unexpected or unpleasant one such as divorce -- the most common life-altering event -- or the death of a spouse. Yet a change in marital status, a career switch, or caring for an elderly parent may affect your earning potential. And this, in turn, can affect your retirement. Here's some advice on how you can minimize the impact of such an event.

The first thing you must do is acknowledge that retirement issues -- especially related to money -- must be part of your coping plan. Ensuring a comfortable retirement should be as much of a priority as ever, even if it may seem more difficult.

Michelle Smith, a transition specialist and financial planner with Wachovia Securities in New York, estimates that after a divorce, the combined expenses of two spouses living separately will probably be 30% more than when they shared a household. Under such circumstances, it might be tempting to cut back on 401(k) or other retirement savings or even to withdraw money from the accounts to cover day-to-day expenses.

Such options should be a last resort, says Smith, because you could set back your retirement for years. If you stop contributing $500 per month for 15 years, assuming an inflation-adjusted return of 5%, you would forgo about $133,000 in future retirement savings. That could mean postponing your retirement -- or it not being as comfortable as you had hoped.

LIVING SIMPLY. What's more, if you withdraw funds from a 401(k) or IRA before you're 59 or older, you'll have to pay a 10% penalty and income tax on the withdrawal -- and you'll lose the benefit of compounding the tax-deferred growth on investments in the account. An IRS rule allows you to withdraw money without penalty, providing you do so over five years, or until you turn 59. But even if you do withdraw it without penalty, you'll lose the compounding benefit. (For details on the tax effects of withdrawing from your 401(k) or IRA, see IRS Publication 590, "Individual Retirement Arrangements".)

Smith suggests that before jeopardizing your retirement savings, you do a thorough analysis of your income, assets, and expenses. You might find that moving to a less expensive home or cutting back on luxuries, ranging from an extra vehicle to expensive vacations, would enable you to keep both your retirement savings -- and your plans -- intact.

Norman, who often counsels middle-management clients who are living on severance after losing their jobs, also advises hanging onto retirement savings. She says people should get used to living on a tighter budget. "When they go out into the marketplace, often they're not as marketable as they think," she says. "And when they get a new job, they may have to take a pay cut," resulting in a hit to retirement savings as well as to the monthly budget.

After divorce, the second most common life-changing event Smith says her clients encounter: the death of a spouse. Smith doesn't expect "someone to go from grieving to retirement planning" immediately. But she points out that retirement finances should be addressed in the context of putting the deceased spouse's estate in order.

ENLIST HELP. The pension benefits or 401(k) savings due to a surviving spouse can be claimed only by contacting plan administrators and sending a copy of the death certificate. Also, she warns, some employers set a deadline "for getting the money out" of a spouse's pension plan.

By definition, the most disruptive life-changing events are almost impossible to predict. That's why it's important to organize all your financial information, including a list of your assets, retirement and pension accounts, insurance policies, Social Security earnings records, and beneficiary records -- and update them on a regular basis, at least once a year. If a crisis arises, the information will be close at hand. It also will be easier to analyze your options before rushing to decisions that you may regret and want to reverse later.

If you're not up to handling the financial tasks and coming up with your own strategies, you should seek help from a friend or family member, or a trusted professional such as your lawyer or financial planner. You've worked and saved for your retirement, and you owe it to yourself to take steps to protect it. In addition to writing Your Retirement for BusinessWeek Online, Hoffman is the author of The Retirement Catch-Up Guide and Bankroll Your Future Retirement with Help from Uncle Sam. You can contact her through her Web site, www.retirementcatchup.com